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Physical Inventory Adjusting Journal Entry

At the end of each reporting period, a company would perform a physical inventory count of the inventory in their warehouse. The company would then compare the inventory amount per the physical count to inventory per the perpetual inventory listing or trial balance. If inventory per the physical count is higher, then the company would record an entry to increase inventory. If inventory per the physical count is lower, then the company would record an entry to decrease inventory.

Example Multiple Choice Question

Tablet Inc performed a physical inventory count on December 31, Year 3 and determined the ending inventory balance was $202,000. Green had the following financial information for Year 3 prior to recording any adjustments:

Beginning inventory of $276,000

Inventory purchases of $168,000

Cost of goods sold of $239,000

What adjusting entry, if any, should Tablet record to inventory for the Year 5 financial statements?

A) Debit cost of goods sold for $3,000 and credit inventory for $3,000

B) Debit inventory for $3,000 and credit cash for $3,000

C) Debit cost of goods sold for $74,000 and credit inventory for $74,000

D) No adjustment is necessary as ending inventory is $202,000 per the physical inventory count.

Solution to Multiple Choice Question

Debit cost of goods sold for $3,000 and credit inventory for $3,000 is correct.

We need to use the financial information to determine the ending inventory per inventory system first, and then compare that balance to ending inventory per the physical inventory count.

Step 1) We can use the BASE method or inventory rollforward to determine ending inventory prior to any adjustments. Start with beginning inventory of $276,000 and add inventory purchases of $168,000 to get COGS available for sale of $444,000. Then we subtract cost of goods sold of $239,000, and that equals ending inventory of $205,000.

Step 2) When we compare ending inventory of $205,000 per the inventory system to $202,000 of inventory per the physical count, we realize inventory is overstated by $3,000, so the company will need to record an adjustment to decrease inventory by $3,000.

Step 3) To decrease inventory by $3,000, the company would debit cost of goods sold for $3,000 and credit inventory for $3,000. This would be an adjusting entry to the adjusted trial balance.

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